Apple (AAPL) Q3 2011 Earnings Call July 19, 2011 5:00 PM ET Operator Good day, everyone, and welcome to this Apple Inc. Third Quarter Fiscal Year 2011 Earnings Release Conference Call. [Operator Instructions] At this time, for opening remarks and introductions, I would now like to turn the call over to Ms. Nancy Paxton, Senior Director of Investor Relations. Please go ahead, ma'am. Nancy Paxton Thank you. Good afternoon, and thanks to everyone for joining us. Speaking today is Apple's CFO, Peter Oppenheimer; and he'll be joined by Apple COO, Tim Cook; and Treasurer, Gary Wipfler for the Q&A session with the analysts. Please note that some of the information you'll hear during our discussion today will consist forward-looking statements, including, without limitation, those regarding revenue, gross margin, operating expenses, other income and expense, stock-based compensation expense, taxes, earnings per share and future products. Actual results or trends could differ materially from our forecast. For more information, please refer to the risk factors discussed in Apple's Form 10-K for 2010, the Form 10-Q for the first 2 quarters of fiscal 2011, and the Form 8-K filed with the SEC today, along with the attached press release. Apple assumes no obligation to update any forward-looking statements or information, which speak as of their respective date. With that, I would like to turn the call over to Peter Oppenheimer for introductory remarks. Peter Oppenheimer Thank you, Nancy. Thank you for joining us. We're thrilled to report the highest quarterly revenue and earnings in Apple history. We also set a new all-time quarterly record for iPhone and iPad sales and a new June quarter record for Mac sales and we're extremely pleased with the momentum of our business. Revenue for the quarter was $28.6 billion, representing year-over-year growth of 82%. This record quarterly revenue topped the previous record established in the most recent December quarter by $1.8 billion and was almost $13 billion over the year ago quarter's result. The tremendous year-over-year increase was fueled primarily by dramatic growth in iPhone and iPad sales in addition to strong growth in Mac sales. Operating margin was a record high of $9.4 billion, representing 32.8% of revenue. Net income was $7.3 billion, topping the previous quarterly record set in the December quarter by $1.3 billion. Net income grew even faster than revenue, increasing 125% year-over-year and translated to earnings per share of $7.79. Turning to the details of the quarter. I'd like to begin with our Mac products and services. We established the new June quarter record with sales of 3.95 million Macs representing a 14% increase over the year ago quarter's result. This growth is more than 4x IDCs most recently published forecast of 3% growth for the PC market overall. Mac sales were particularly strong in our Asia-Pacific segment, where we experienced a 57% year-over-year increase in total Macs sold. We generated healthy Mac growth in both desktop and portable categories. In May, we updated the iMac with the next-generation quad core processors, powerful new graphics, high speed portable I/O technology and a new space time, HD camera. The growth in Mac portable sales was driven by strong sales of MacBook Pro, as well as MacBook Air. We began to enter the quarter with between 3 and 4 weeks of Mac channel inventory. We are very excited to be launching Mac OS X Lion tomorrow. The Lion includes more than 250 new features such as a multi-touch gestures, system wide support for full screen apps,

Mission Control, which is an innovative view of everything running on your Mac and much more. Moving to our music products. We sold 7.5 million iPods compared to 9.4 million in the year ago quarter. Total iPod sales were ahead of our expectations and iPod touch continues to account for over half of all iPods sold. iPod share of the U.S. market for MP3 players remains at over 70% based on the latest monthly data published by MPD. And iPod continued to be the top-selling MP3 player in most countries we track based on the latest data published by GFK. We ended the quarter within our target range of 4 to 6 weeks of iPod channel inventory. The iTunes store generated strong results with revenue of almost $1.4 billion. iTunes revenue was up 36% year-over-year, thanks primarily to continued strong sales of music, video and apps. With more than 225 million accounts, iTunes is the #1 music retailer in the world and customers have downloaded more than 15 billion songs today. I'd now like to turn to the iPhone. We were thrilled to sell a record 20.3 million iPhones compared to 8.4 million in the previous June quarter. This represents 142% year-over-year growth, which is more than double IDC's latest published estimate of 67% growth for the global smartphone market overall in the June quarter. Recognized revenue from iPhone handset and accessory sales were $13.3 billion during the quarter compared to $5.3 billion in the year ago quarter, an increase of 150%. We continue to experience very strong year-over-year iPhone sales growth in all of our operating segments. iPhone sales momentum in the Asia-Pacific region was particularly robust with sales almost quadrupling year-over-year. We continue to increase our overall iPhone manufacturing capacity in the quarter. We were pleased to launch a number of new carrier relationships. And by the end of the quarter, iPhone was available through 228 carriers in 105 countries, compared to 186 carriers in 90 countries as of the end of the March quarter. We ended the quarter with about 5.9 million iPhones in channel inventory, a sequential increase of about 700,000 to support strong iPhone demand, carrier addition and expanded distribution. We remained within our target range of 4 to 6 weeks of iPhone channel inventory. iPhone continues to be adopted as the standard across the enterprise with 91% of the Fortune 500 deployed or testing the device, up from 88% last quarter. We're also seeing great growth in scale worldwide. Today, 57% of Global 500 companies are testing or deploying iPhone, fueled by strong employee demand and opportunities for custom App development. Some examples of Global 500 companies supporting iPhones on their corporate networks, include AXA, Credit Agricole, Nestlé, Dow Chemical, GlaxoSmithKline, SUPERVALU and Comcast. Turning to iPad. We continue to be thrilled with its incredible momentum. We sold a record 9.2 million iPads during the June quarter compared to 3.3 million in the year ago quarter, an increase of 183%. We were able to increase production sequentially by over 4.5 million and we sold every iPad we can make. We launched iPad 2 in an additional 36 countries. And combining the original iPad and iPad 2, we ended the quarter with distribution in a total of 64 countries. Recognized revenue from sales of iPad and iPad accessories during the quarter was over 6 billion, compared to 2.2 billion in the year ago quarter, an increase of 179%. We ended the quarter with about 1.05 million iPads in channel inventory, a sequential increase of about 200,000, which was well below our target range of 4 to 6 weeks. Today, 86% of the Fortune 500 are deploying or testing iPad within their enterprises, up from 75% last

quarter. We are also seeing strong adoption internationally with 47% of Global 500 companies testing or deploying iPad. In the 15 months since iPad has shipped, we've seen iPads used in the enterprise in ways we could have never imagined. Companies like Boston Scientific, Xerox and Salesforce.com are deploying thousands of iPads and revolutionize in how their sales teams engage their customers. iPad is being used inside the country's top hospitals like HCA and Cedars-Sinai and in retail at Nordstrom and at Esteé Lauder's Clinique counters. General Electric, SAP and Standard Charter have developed internal Apps for training, currency tracking and business process management to help make employees even more productive. And Alaska Airlines and American Airlines are using the iPad in cockpit to replace paper-based navigational and reference information pilots carry with him on every flight. We continue to be delighted by the diverse and sometimes, unexpected use cases we see around iPad. Combining iPhone, iPad and iPod touch, we reached over 222 million cumulative iOS device sales through the end of the June quarter. Last month, we provided a preview of iOS 5, which includes over 200 new features such as notification center for viewing and managing notifications without interruption, iMessage for sending text messages, photos and videos between iOS devices and Newsstand, a new way to purchase an organized newspaper and magazine subscriptions. With the new PC-free feature, iOS 5 users will be able to activate and set up iOS devices right out of the box with no computer required. We are looking forward to launching iOS 5 this fall. In June, we also provided a preview of iCloud, our set of free new services that work seamlessly with applications on the customer's iPhone, iPad, iPod touch, Mac or PC to automatically and wirelessly store content in the cloud, as well as push it to all the users' devices. We think customers will love using iCloud and we look forward to its release in the fall. The App Store continues to be incredibly successful with over 425,000 apps available in over 15 billion downloads to date. And as we mentioned last month, we're extremely pleased to have reached over 2.5 billion in cumulative payments to iOS developer, far ahead of any of our competitors. I'd now like to turn to the Apple Retail Stores, which generated record June quarter results. Revenue grew to $3.5 billion from $2.6 billion in the year ago quarter, an increase of 36%. This growth was driven primarily by higher volumes of iPad, iPhones and Macs. The store sold 768,000 Macs compared to 677,000 Macs in the year ago quarter, an increase of 13%. And about half of the Macs sold in our stores during the June quarter were to customers who had never owned a Mac before. We opened 4 new stores in the quarter, including 2 in France, 1 in the U.K. and 1 in Germany, ending with a total of 327. With an average of 325 stores open, average revenue per store was $10.8 million compared to $9 million in the year ago quarter, an increase of 20%. Retail segment margin was $828 million compared to $593 million in the year ago quarter. Store traffic continues to be very strong. We hosted 73.7 million visitors in the June quarter compared to 60.5 million in the year ago quarter, an increase of 22%.

Our recently launched, personal setup program is off to a great start. Customers love this new feature the retail store experience that they're up and running with their new products before they leave. During the June quarter, we set up over 2 million Macs, iPhone, iPads and iPods collectively. We plan to open 30 new stores in the September quarter, including our first store in Hong Kong. That will bring us to a total of 40 store openings in fiscal 2011, including 28 new stores outside United States. Total company gross margin was 41.7%, which was 370 basis points higher than our guidance. This difference was a result of 3 approximately equal factors: a stronger mix of iPhone; lower commodity and other costs, which included some one-time items; and leverage on the higher revenue. Operating expenses were $2.54 billion and included $232 million in stock based compensation expense. OI&E was $172 million and the tax rate for the quarter was 23.5%. Turning to cash. Our cash for short-term and long-term marketable securities totaled $76.2 billion at the end of the June quarter compared to $65.8 billion at the end of the March quarter, a sequential increase of $10.4 billion. Cash flow from operations was $11.1 billion, an increase of 131% year-over-year. I'd now like to talk about the accounting implications of some of the new aspects of our products and services. First, when we deliver Mac OS X Lion to customers, we are now including the right to receive future unspecified minor software upgrades and features when and if they become available for both the Mac operating system and our suite of Mac OS allied [ph] applications. We will continue to charge for standalone sales of our periodic major OS upgrades, such as Lion, as well as major upgrades of iLife. Revenue from these standalone sales will now be fully deferred at the time of sale and recognized over a period of 3 years. In addition to this future software upgrade right, Mac customers will have access to iCloud services when they become available in the fall. We estimate that the combined value of the software upgrade right and iCloud services for Mac customers is $22. Therefore, as of June 6, we began deferring $22 of the revenue associated with each new Mac sold. And we will recognize these deferred amounts as revenue over a period of 4 years. Purchasers of IOS devices will also have access to iCloud. So beginning on June 6, we begin to sign a portion of the revenue from each iOS device sold to represent the estimated value of the right to receive iCloud services when they become available. That deferred amount is in addition to the amount that we will already deferring for each iOS device sold to represent the right to receive future iOS software upgrades. As a result, beginning on June 6, we are deferring a total of $16 of revenue for each iPhone and iPad sold and a total of $11 for each iPod touch sold and recognizing those amounts over a period of 2 years. As we move ahead into the September quarter, I'd like to review our outlook, which includes the types of forward-looking statements that Nancy referred to at the beginning of the call. We expect revenue to be about $25 billion compared to $20.3 billion in the September quarter last year. We expect gross margin to be about 38%, reflecting approximately $55 million related to stock-based compensation expense. We expect OpEx to be about $2.725 billion, including about $245 million related to stock-based compensation expense.We expect OI&E to be about $50 million and we expect the tax rate to be about 24%. We

are targeting EPS of about $5.50. In closing, we're extremely pleased with our record revenue and earnings and the tremendous customer response to our products. Through the first 3 quarters of fiscal 2011, we have generated $35 billion in year-over-year revenue growth translating to a 78% increase. At the same time, we have generated over $9.5 billion in year-over-year earnings growth, representing a 99% increase. We remain very excited about our new product pipeline and we look forward to releasing the Mac OS X Lion tomorrow and bring in the wonderful new features of iOS 5 and iCloud to customers this fall. With that, I'd like to open the call to questions. Nancy Paxton [Operator Instructions]